Inside the Market’s roundup of some of today’s key analyst actions
With valuations now within "shooting distance of cycle lows," Raymond James analyst David Quezada raised his rating for quartet of TSX-listed independent power producers on Wednesday, believing weakness in the sector is "overdone."
“Over the past month the COVID-19 pandemic and attendant recession fears have spurred an indiscriminate market sell-off and slashed roughly 35 per cent from IPP share prices in our coverage universe (vs. the TSX down 32 per cent),” he said. “We believe this pronounced weakness is at odds with the underlying stability of these high quality, defensive businesses and highlight most names are now reaching historically attractive valuation levels. What’s more, a marked divergence has emerged in the historically negative relationship between IPP valuations and bond rates, in our view. In the past, negative moves in bond rates have had a reliably positive effect on valuations — a relationship we expect will re-assert itself over time providing a lift to IPP trading multiples.”
Mr. Quezada did acknowledge that gains made prior to the emergence of COVID-19 as a significant market threat made the sector vulnerable to a “pronounced” pullback.
"However, we also maintain conviction that the reasonsfor the prior strength (ESG, de-carbonization, momentum for renewable power) represent durable tailwinds that will ultimately drive fund flows back into these high quality names," the analyst said.
“As we have highlighted during past periods of weakness in the sector (Oct-18 being the last good example), the renewable IPPs face little exposure to an economic downturn or lower power demand with largely contracted revenues, abundantly manageable debt loads, limited near term maturities, secure dividend payouts, and what remains a lengthy runway of growth opportunities in key regions (details on these topics below)," he said. "While certain construction projects may see delays as contractor safety is prioritized, we regard current operations for these companies as highly stable.”
Mr. Quezada made the following rating changes:
- Boralex Inc. (BLX-T) to “strong buy” from “outperform” with a $32 target. The average on the Street is $30.38.
- Capital Power Corp. (CPX-T) to “outperform” from “market perform” with a $36 target, down from $39. Average: $37.30.
- Innergex Renewable Energy Ltd. (INE-T) to “strong buy” from “outperform” with a $22 target. Average: $21.25.
- TransAlta Renewables Inc. (RNW-T) to “outperform” from “market perform” with a $16.50 target. Average: $16.56.
“These upgrades come as each of RNW and CPX have moved toward the low end of historical trading ranges while sporting safe, elevated dividend yields of 7.6 per cent and 8.5 per cent respectively," said Mr. Quezada. "While we do not claim any special insight on where the bottom lies in this environment, we have conviction that current levels will ultimately represent exceptional value.”
In the wake of announcing a reduction in its dividend and 2020 capital budget on Tuesday, Industrial Alliance Securities analyst Elias Foscolos raised his rating for Secure Energy Services Inc. (SES-T), expecting its business to prove resilient through the industry’s recent downturn and seeing it possess “adequate” liquidity.
“SES’s corporate update [Tuesday] announcing a dividend reduction and trimmed growth capital was anticipated. The combination of these two actions should allow SES to achieve positive free cash flow as its revenue base is 75-per-cent production-related. Furthermore, the Company has room on its credit facilities. Based on management’s proactive actions, our unchanged $3.25 target price results in substantial capital appreciation upside and justifies raising our rating on SES to Speculative Buy (previously Hold).”
After the bell, the Calgary-based company announced actions in response to the spread of COVID-19 and the "rapid decline in global energy prices."
Secure slashed its capital budget for the year by 25 per cent, or $20-million, from its previous guidance of $80-billion. It said remaining capital will be " primarily spent in the second quarter for projects that are near completion and are expected to provide an immediate cash contribution."
For 2021, a capital budget of $15-million was announced, which Mr. Foscolos said fell short of his expectation and "is likely below a sustainable normalized level."
With that move, Secure reduced its monthly dividend to 0.25 cents from 2.25 cents per share.
“SES provided some reassurance to investors by highlighting that 75 per cent of its revenue base is driven by production-related volumes with a portion being contracted,” said Mr. Foscolos. “The company did confirm that production volumes will also be impacted by low crude oil prices and reduced producer activity. SES’s $600-million ($330-million drawn) first lien revolver matures in 2023 and its $130-million second lien facility (fully drawn) matures in July 2021.”
Mr. Foscolos’s target of $3.25 per share falls below the $5.70 average on the Street.
In a research report title An Eye on WTI, Industrial Alliance Securities analyst Michael Charlton evaluated energy companies for a “lower-for-longer” scenario and with the expectation of an escalating cash crunch.
“The energy sector has gone from bad to worse inside of a fortnight; lack of pipelines and egress options were last year’s problems, this year it’s a price war as Saudi Arabia and Russia vie for more market share and we continue to see huge demand erosion from COVID-19 quickly expanding worldwide,” he said. "Availability of crude storage options both on land and water are seen to be evaporating at today’s low oil prices. These forces are combining to create the perfect storm, decimating crude prices that could last for the rest of the year; a shock that an already fragile Canadian energy sector didn’t need and is now faced with more uncertainty.
"The good news is that most operators have been facing some form of hardship for years and have become accustomed to optimizing costs and capital while operating within cash flow. The gas producers have never looked so stable and although we expect the heavier crude and liquids producers to be most affected at today’s prices, we believe they have all proven resilient and will store or shut in uneconomical production. The big question today is who can survive at these crude prices and can they weather the storm from a cost perspective in a lower-for-longer scenario? In light of the new reality of lower oil prices, the unknowns surrounding potential demand disruptions from COVID-19 and also the depth and duration of the oil price wars, we have re-run all our capex, production, cash flow and valuation estimates across our universe."
Mr. Charlton downgraded his ratings for a pair of companies in the report.
Seeing a probability that the it will encounter a credit crunch at current commodity pricing, he moved Surge Energy Inc. (SGY-T) to “sell” from “speculative buy” with a 10-cent target, down from 75 cents and below the $1.13 average on the Street.
“Surge Energy looks to be in a tight spot, as the company’s last couple of bank redeterminations were problematic and put Surge in a position to quickly have to pay down the debt,” he said. “The Company is $320-million drawn on a $350-million line and recently cut its dividend to 1 cent per share annually ahead of its May 31 semi-annual redetermination. Given the drop in commodity prices and 84-per-cent liquid weighting combined with a hefty $270-million ARO, we see real potential for the company to slip off-side in 2020 with its bank as lower commodity prices are applied across its entire liquid portion of its PDP reserve base. We have been concerned about Surge’s high levels of debt for some time now, and following the company’s release of its 2019 annual results, we were reminded why. With lower cash flow estimates now running through 2021, we see further pressure coming for the company to reduce debt, and given the dividend cut already announced and accounted for, forecasted cash flow does not look to be enough to perhaps even fund a maintenance only capital program. Therefore, we are not convinced that the bank will be very willing to advance this troubled company additional funds in the face of both dwindling cash flow and declining base reserve valuations."
Mr. Charlton also moved Freehold Royalties Ltd. (FRU-T) to “hold” from “speculative buy” with a $3 target, down from $9.25 and below the $8.75 average.
“Freehold’s advantage continues to be structural in nature, as the Royalty Co has no direct operating or transportation costs, let alone maintenance capital requirements which drives both its margin and the FCF generation advantage,” he said. “However, it will be affected through its GORRs and as lessees potentially realign its respective capital programs in response to the drastic decline seen in WTI pricing. As such, we expect Freehold to reduce its dividend from its current 63 cents per share as it historically targets the lower end of its 60-80-per-cent payout ratio range, which at today’s $73-million cash flow estimate would put the dividend more likely in the 30-40 cents per share range. With this in mind we have realigned our target price to more accurately reflect today’s pricing realities which maps to a more conservative $3.00 target price.”
Seeing an “attractive” risk-return profile, Industrial Alliance Securities analyst Brad Sturges raised his rating for Automotive Properties REIT (APR.UN-T) following the release of in-line fourth-quarter financial results.
He said the move to "strong buy" from "buy" was made to "reflect its long-term, triple net leased (NNN) cash flows, strong liquidity position, low financial leverage, and the potential for improving Canadian dealership property consolidation opportunities in the medium term."
Mr. Sturges emphasized that the Canadian automotive dealership industry has exhibited resiliency during economic turnarounds, noting 80 per cent of average dealership profits have been generated from revenue sources other than new car retail sales.
"In 2020, the global healthcare crisis due to the COVID-19 virus outbreak is expected to have a material negative impact on North American automotive dealership revenue, including a decline in automotive retail sales in the near term," he said. "However, at this stage, we do believe that North American dealership profitability could be supported on a medium-term basis by an increase in other revenue sources such as parts, repairs and service, finance and insurance revenue, while new automotive retail sales could take a longer period of time to recover."
He also thinks consolidation of the “highly fragmented” Canadian dealership property sector may accelerate due to the expected slowdown in the automotive industry.
“The COVID-19 virus outbreak is expected to have a near-term negative effect on Canadian operating dealership profitability,” he said. “However, we expect that large Canadian dealership operating groups such as the REIT’s largest tenant, the Dilawri Group (Dilawri), may be well positioned to weather the storm, and to take advantage of dealership consolidation opportunities in the medium term. Notably, Dilawri’s EBITDAR coverage ratio was 3.5 times at Dec. 31.”
Mr. Sturges trimmed his target for the REIT's units to $11 from $13. The average is $11.06.
Elsewhere, Desjardins Securities’ Kyle Stanley cut his target to $10 from $12.75, keeping a “hold” rating.
Mr. Stanley said: “Given APR’s long-term (13 years) net lease profile, minimal near-term debt maturities and healthy liquidity position, we believe it is well-positioned to weather this storm of economic uncertainty.”
Credit Suisse analyst Manav Gupta seeing the Canadian mid-cap energy sector remaining "challenged" in the near-term with the market focusing on free cash-flow deficits without rewarding growth.
The analyst said he sees Baytex as "basically a debt reduction story."
“In 2019, BTE lowered debt by $393-million,” he said. “In the current low commodity price environment, we see the debt reduction process coming to a grinding halt, which is a key reason for our downgrade. We have BTE generating $298-million in FFO [funds from operations], which fully covers capex of $260-million, but leaves only $40-million for debt repayment in 2020. While the company lowered 2020 capex guidance by 50 per cent to $260-$290-million, its capex is still front end loaded with BTE spending $190-million in 1Q 2020.”
On NuVista, Mr. Gupta said: “In 2020, we have NVA generating $180-million in FFO, which does not fully cover capex of $240-million loaded. Off the $240-million capex NVA expects to spend, $135-million is in 1Q 2020. As a result we see up to a $70-million in FCF deficit in 1Q 2020 itself. In the current environment, the market is focused on FCF neutrality while NVA is offering growth.”
Citing “heightened liquidity concerns in the context of the company’s weak balance sheet in a very depressed zinc price environment,” Scotia Capital analyst Orest Wowkodaw lowered Titan Mining Corp. (TI-T) to “sector underperform” from “sector perform.”
"According to the Q4/19 financials released [Tuesday], the company had total available liquidity of only $1.7-million in cash and an elevated net debt position of $30.0-million, including $10.2-million of bank debt maturing in Q2/21," he said. "Moreover, with spot zinc prices now well below $1.00 per pound, we anticipate the Empire State Mine (ESM) to burn cash for the foreseeable future. While we anticipate the company's Chairman and largest shareholder, Mr. Richard Warke, to keep the company a going concern via additional loans, the future of [The Empire State Mine] remains highly uncertain in our view. An updated mine plan for ESM is now anticipated in H1/20."
Mr. Wowkodaw lowered his target to 15 cents from 30 cents. The average is 27 cents.
Citi analyst William Katz moved his long-standing negative view of the U.S. retail brokerage sector to a "positive stance" on Wednesday, despite moving his earnings expectations for 2020 through 2024 "sharply" lower.
In justifying his new stance, the analyst pointed to four factors: “We believe rates and the bulk of market risk are now discounted, and our house view calls for modest yield curve steepening into year-end 2020, which could bolster these stocks; Second, we see two favorable structural changes emerging from this cycle: A) greater import around Advice; and, B) likely higher Client Cash allocations, the latter bolstering EPS even as rate expectations flattened; Third, we expect an acceleration in FA movement as markets settle, accelerating de novo and deal-related NNA opportunities; and, Fourth, following the incremental gap down in these stocks month-to-date/quarter-to-date, we believe the risk/rewards are now compelling, even as we again sharply lower our estimates.”
Mr. Katz raised his ratings for the four companies in his coverage universe. In order of preference, they are:
- LPL Financial Holdings Inc. (LPLA-Q) to “buy” from “neutral” with a US$65 target, down from US$79. The average on the Street is US$87.13.
- TD Ameritrade Holding Corp. (AMTD-Q) to “buy” from “neutral” with a US$40 target, down from US$43. Average: US$45.46.
- The Charles Schwab Corp. (SCHW-N) to “buy” from “neutral” with a US$37 target, down from US$40. Average: US$44.38.
- Raymond James Financial Inc. (RJF-N) to “neutral” from “sell” with a US$60 target, down from US$71. Average: US$84.63.
"Cognizant of selected ratings changes to the downside just a few weeks, much has changed as markets have further tumbled, ST rates have effectively hit the zero bound again as the FOMC cut another 100 basis points and the Group has gapped lower," he said. "However, we now think these stocks could have collectively bottomed and residual upside is broadly compelling, with the exception remaining RJF, in our view.
“We refresh our ranking, with LPLA our top pick still. However, we rank AMTD ahead of SCHW followed by RJF. We open a 90 Day Positive Catalyst Watch on AMTD as we think the deal with SCHW will get completed and the merger arb gap ... is likely to close. While we think absolute downside in RJF is limited at current levels, we still see the stock range-bound in light of lingering Credit and Capital Market risks, and would use the shares as a funding vehicle nonetheless.”
Citing its “sustained price compression,” Echelon Wealth Partners analyst Doug Loe raised Centric Health Corp. (CHH-T) to “buy” from “hold” in the wake of Tuesday’s announcement of the acquisition of privately held Remedy Holdings Inc.
“We remain positive about Centric’s recent focus on building out its LTC Rx operations, a decision that seems prudent based on the historically strong EBITDA margins that this business has generated and on recent margin recovery that transpired sequentially throughout fiscal 2019,” said Mr. Loe.
His target rose to 25 cents from 20 cents. The average is 30 cents.
“Despite volatile capital markets macro-environment, we believe that Centric’s projected EBITDA growth trajectory and recent price compression justifies upgrading the stock,” he said.
In other analyst actions:
* JP Morgan analyst Arun Jayaram cut Seven Generations Energy Ltd. (VII-T) to “neutral” from “overweight”
* Tudor Pickering Holt cut Cenovus Energy Inc. (CVE-T), Crescent Point Energy Corp. (CPG-T) and MEG Energy Corp. (MEG-T) to “hold” from “buy.” The firm raised Birchcliff Energy Ltd. (BIR-T) to “hold” from “sell.”
* Echelon Wealth Partners analyst Rob Goff lowered Pivot Technology Solutions Inc. (PTG-T) to “speculative buy” from “buy” with a $2.50 target, down from $3.30, which is the current consensus.
"The move ... reflects the modest market capitalization, takes a conservative view ahead of prospective acquisitions and reflects current market," he said.
* Mr. Goff also lowered Martello Technologies Group Inc. (MTLO-X) to “speculative buy” from “buy” with a 45-cent target, down from 55 cents. The average is 50 cents.
“Our rating move to Speculative Buy along with our PT revision reflects on the higher cost of equity assumptions and challenging market,” he said. “We hold the potential to raise our PT with successful execution, accretive acquisitions and a return to stronger capital markets supporting the lower cost of capital assumptions. These revisions coincide with a transition in primary coverage.”